Calif. Taxpayers Due Refunds May Get IOUs

Controller warns state may be cash-strapped as soon as February

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Updated at 10:42 AM PDT on Wednesday, Dec 31, 2008

If you expect you'll be getting a refund from California when you file your 2008 state income tax return, be prepared: you may instead receive a "registered warrant." Translation: an IOU.

California is rapidly running out of money. Blame it on the state budget deficit that continues to bleed billions of dollars from California's reserves. Facing inadequate credit to make up the difference, California's Controller John Chiang warns that by the end of February, the nation's most populous state may not be able to pay some of its debts, and instead be reduced to issuing those creditors IOUs.

"My office has projected that, in approximately 60 days, there will be insufficient cash available to meet all expenditures reflected in the 2008-09 Budget Act," stated a Tuesday letter from Controller Chiang to the directors of all state agencies. "To ensure that the State can meet its obligations to schools, debt service, and others entitled to payment under the State Constitution, federal law, or court order. California may begin, as early as February 1, 2009, issuing registered warrants...commonly referred to as IOUs...to individuals and entities in lieu of regular payments."

California has not resorted to IOUs since the 1992 budget crisis when Pete Wilson was governor. Back then, some 100,000 state employees got IOUs instead of paychecks for two months until the state approved a budget. The 1992 crisis came during summer, well past the tax season, but at least 12,000 tax refunds were also issued as IOUs, according to a contemporaneous report in the Los Angeles Times.

State workers filed a lawsuit, arguing the IOUs violated the federal Fair Labor Standards Act. They were awarded damages. In this current cash crisis, The Controller's office expects that hourly state employees would continue to receive paychecks. But IOUs could be issued to elected state officials, including legislators and judges, and their appointed staff, some 1700 in all, "as well as tax refunds owed to individuals and businesses," according to Chaing aide Hallye Jordan.

The Controller himself remains in a Texas hospital where he was taken after falling ill during a visit with family. Chiang has remained in communication with his staff by phone, Jordan told NBC Los Angeles Tuesday evening.

The Controller's office will not take the emergency steps outlined in the letter to state agencies, Jordan said, if California can resolve its budget crisis in the next few weeks. But no new budget package has been proposed since the one presented by Democratic lawmakers was rejected by Governor Arnold Schwarzenegger as inadequate. "We've made very little progress the past couple of weeks," said Aaron McClear, an aide to Gov. Schwarzenegger, while the Governor was away from the capital on a holiday vacation.

Even without a deficit resolution, issuing IOUs is not the only option for tax refunds. The state could simply delay payment. Under the law, it has until May 30, Jordan said.

In 1992, banks honored the state's IOUs, cashing them on demand, and then receiving an additional 5% from the state when it made good on the obligations. In effect, the IOUs served the state as unsecured bridge loans from banks. But this time around, with credit tight and banks still feeling the impact of the fall meltdown in the financial services industry, it is not yet clear how banks will respond.

"Nobody's making any decision whether 'Bank X' will take the IOUs as money or not," said Brian Tobin, a Culver City based tax preparer. At the request of NBC Los Angeles, Tobin reviewed a copy of Chiang's letter. Tobin noted that in past years, California's Franchise Tax Board has processed electronic refunds in as short a period as a week. This raises the possibility that taxpayers with simple returns who file as soon as possible after New Year's may be able to receive refunds before the proposed February start date for issuing IOUs.

Those who could be most affected are taxpayers who routinely plan for large refunds as a means of saving for anticipated expenses, such as property taxes which are also due in April. But with notice coming at year's end, there is not time for those taxpayers to adjust their withholding or take other steps to try to capture their return in advance from the state's coffers. "They've got their money taken out of your paycheck. That's it," Tobin said.

One final irony, Tobin sees: electronic deposit refunds are inexpensive to do. Instead sending out IOUs is a more costly procedure for a state looking to save money.